Ignore Reports of the Death of the Individual Investor

First came the Wall Street Journal's July 12 article, "Small Investors Flee Stocks, Changing Market Dynamics." Last weekend, the New York Times tagged along with the article, "In Striking Shift, Small Investors Flee Stock Market."

That's the new cool thing to do today: proclaim the death of the individual stock investor. Both articles cite the same data and come to the same conclusion: The average investor has had it and is throwing in the towel after years of poor returns.

Ain't buying what you're selling
These articles are fun reads that attracted tons of attention. But both are also misleading to the point of possibly being entirely wrong, thanks to a clever journalism tactic of citing one breezy fact followed by layers of emotion-laced anecdotal personal stories to solidify the arguments.

The foundation of both articles is mutual-fund flow data from the Investment Company Institute (ICI), which shows investors recently pulling money out of stock market mutual funds, while demand for bonds explodes. Thus, they conclude, stock investors are abandoning ship.

But all this data shows is that investors are fleeing stock mutual funds. Neither article attempts to address the truism that mutual funds have lost sway over the years as other low-cost investment vehicles, particularly ETFs, have taken their place.

Coincidentally, ICI also tracks ETF assets. And guess what? From February 2009 to June 2010, during which time investors pulled $9 billion out of stock market mutual funds, stock market ETF assets increased by more than $250 billion. Some of this reflects capital appreciation and not new money flows. But even during periods when the market went nowhere -- October 2009 through June 2010 -- stock market mutual funds outflows of $4 billion were dwarfed by stock market ETF assets increasing by $51 billion.

There's a good chance, therefore, that plenty of the money fleeing stock market mutual funds and terrorizing the media is simply moving into stock market ETFs. This isn't surprising: Many ETFs achieve everything a mutual fund can for a fraction of the cost. Who wouldn't want to exchange a mutual fund charging 1.5% for an identical ETF that charges nearly nothing? Outflows from stock mutual funds might not signal the death of the stock investor as much as they do the death of the mutual fund.

But that poses another question: If stock assets haven't been whittled away, then where is the torrent of cash flowing into bonds coming from? The answer might again be found in ICI's data, which shows investors have pulled over $1 trillion out of money market funds since early 2009. Hungry for yield in a zero-interest rate environment, that's not surprising either.

Ready for the next round
Individual investors' confidence in the stock market has surely been trampled senseless, but assuming their demise seems overstated. Consider E*TRADE Financial's (Nasdaq: ETFC) year-over-year quarterly results: Number of brokerage accounts? Up. Total assets? Up. Margin debt? Way up. Hardly what you'd expect from a dying crowd.

At the same time, it's well documented that bonds are currently encircled by insatiable, almost psychotic, demand, while the appetite and valuation outlook for stocks is relatively muted.

What this all shows, I think, are individual stock investors who have not given up on stocks, but are hanging on while expecting much less out of them. Any way you spin it, that's a positive development. It shows rationality making a comeback; it shows bubbles being burst; and, most importantly, it has made stock picking about as lucrative as it's been in years.

For example, the current yield on 10-year Treasury bonds is below 2.6%, and yet several high-quality stocks with durable franchises easily best that:

Source: Capital IQ, a division of Standard & Poor's.

I'm not sure why anyone with more than a short time horizon would prefer Treasury debt to any of these companies. More than that, I'm confident there are plenty of individual investors (like you!) ready and able to exploit these opportunities.

Your death, in other words, has been grossly exaggerated.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.